Albert Einstein is credited with saying that everything should be made as simple as possible, but not simpler.
That epigram may seem enigmatic, perhaps even opaque, upon first hearing. But it’s an invaluable rule of thumb. Legendary investor Charlie Munger, now 94 years old, has updated and applied Einstein’s wisdom for the new millennium in the modern language of computing. Charlie has fashioned for us, in a three-word instruction, the Fundamental Algorithm:
Repeat what works!
Just mull that over a few times.
Repeat what works! is the operating system gently humming inside every form of success, from math to physics to chemistry, biology, evolution and — yes — the stock market.
Is it obvious once you learn it?
Yes, and No. We need maxims and algorithms to teach ourselves things that are not intuitive.
So let’s talk markets. An intuitive algorithm for succeeding in the stock market is:
Buy a rising stock.Sell and take profits.Buy another rising stock.Repeat until rich!
It’s intuitive, for sure.
But that intuitive algorithm does not work! It would require each and every successive investment to go up. One billion times zero is still zero.
Yet people apply that intuitive algorithm innocently and endlessly even as it fails, again and again, to bring success in the stock market.
What algorithm does work in the stock market?
Live well within your means.
Invest the savings in tax-deferred retirement accounts.
Diversify the bulk of your investments in low-cost index funds to grow your wealth and prevent ruin.
Let your investments grow and dividends compound undisturbed all your life long.
So simple. But it works. When you retire, you will be rich!
Look at Vanguard. Look at Berkshire Hathaway. Listen to Jack Bogle, Warren Buffett and, of course, Charlie Munger.
Now, Charlie’s Fundamental Algorithm has a corollary. One could argue the corollary is implicit, but given human nature it should be made explicit:
Stop what does not work!
Applying this to markets, we can derive the following:
Do not live beyond your means and compound debt or you will be poor all your life.
Do not gamble in markets or anyplace else.
Do not disobey the fundamental algorithm!
Now, in the face of all this simple logic, why wouldn’t we practice the things that work and not practice the things that do not?
Unfortunately, the things that do not work are very seductive. That’s because they are:
Intuitive, though wrong.
Fun and exciting, though self-destructive.
Habitual, though bad habits.
Done by everyone else, though they should not be.
So how do we avoid what is intuitive, fun, habitual and endorsed by the madding crowd?
That’s easy, too, but much harder to apply:
Use the fundamental algorithm instead of intuition.
Never play the financial markets for fun.
Break those bad habits! You can: fifty years ago 40% of adults smoked. Now, only 15.5% do!
Remember that if you follow the crowd, you can’t win the game.
Thanks to you, Charlie, and you as well, Albert.